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Smart beta enters mainstream

Investors are progressively shifting away from underperforming, high fee charging active funds to smart beta strategies, according to a new survey spanning Asia-Pacific.

According to VanEck's fourth annual smart beta survey conducted in July and August 2019 financial professionals using smart beta strategies overwhelmingly believe they represent good value for money, while almost two thirds (62 per cent) believe smart beta strategies will outperform active strategies. The survey is the largest of its kind in the Asia Pacific region. This year, 221 financial professionals working in an advisory capacity in Australia responded.

The majority of advisers (66 per cent) use smart beta strategies to replace actively managed funds and most (68 per cent) are very or extremely satisfied with their investments. For those not using smart beta strategies, 65 per cent of financial professionals plan to increase their smart beta allocation in the next 12 months. This highlights that the movement towards smart beta ETFs - which deliver targeted investment outcomes through rules-based investing – is taking hold of the Australian investment market and becoming mainstream.

Performance the key draw

Strong performance is the number one motivating factor for financial professionals to use smart beta strategies. Investors and their advisers are realising that active funds often underperform their benchmarks, so investors are shifting to smart beta to seek strong performance outcomes for much lower fees. Other motivating reasons to use smart beta include reduced volatility, improved portfolio diversification and increased transparency as the chart below shows.

How motivating would each of these reasons be to start using smart beta?

Source: VanEck Fourth Annual Smart Beta Survey, August 2019

Awareness of smart beta strategies has increased considerably since the survey began, with 93 per cent of respondents familiar with smart beta, an increase from 81 per cent in 2016.

Many financial professionals (46 per cent) are now using smart beta strategies in client's portfolios according to the survey, compared to only a third (37 per cent) in 2016. Most financial professionals use smart beta ETFs for Australian equity (79 per cent) and international equity (78 per cent) exposure. The most popular smart beta strategies are equal or alternative weighted strategies (58 per cent), single factor quality strategies (45 per cent), multi-factor combinations (41 per cent) and dividend, income or yield weighted strategies (24 per cent).

The survey also reveals very high levels of satisfaction among smart beta users, with seven out of 10 (73 per cent) people using smart beta strategies very satisfied or extremely satisfied with their smart beta investments.

How happy are you with your smart beta investments?

Source: VanEck Fourth Annual Smart Beta Survey, August 2019

The persistent underperformance of active managers is backed by research from S&P Dow Jones Indices. The SPIVA Australia Scorecard recently found that over the one-year period ending June 2019, 93.2 per cent of Australian large-cap equity funds underperformed the S&P/ASX 200 index. The Scorecard has observed consistent underperformance for the majority of Australian active funds in most categories over the longer periods (5-, 10-, and 15-year periods).

Those are staggering numbers and explain why active managers are losing market share to smart beta strategies. A recent VanEck white paper, When are fees too high? A study of Australian equities management, found most Australian active manager will be forced out of existence by disruptive smart beta investment strategies, which offer the same or better outcomes for lower cost.

The white paper found that most Australian equity funds should be charging fees between 0.35 per cent p.a. and 0.50 per cent p.a. as most of their performance can be explained by factors, the same factors used in smart beta strategies. Unless their performance improves, active managers are likely to keep losing market share to smart beta ETFs.

ESG not yet mainstream

Surprisingly, the survey reveals that only 20 per cent are currently invested in any type of ESG strategy. Investors and their advisers are still unsure about ESG investment approaches, with 44 per cent revealing this uncertainty. Yet 50 per cent would switch to ESG if it gets a high research rating.

Over time, we expect low-cost smart beta sustainable strategies to gain appeal among investors seeking to back companies making a positive social impact. There is recognition in the financial community that investment portfolios may benefit from the introduction of ESG and sustainability criteria, with some studies indicating the possibility of outperformance over the longer term. Smart beta opens up sustainable investing for a low cost, compared to actively managed funds which often charge higher fees for sustainable strategies.

Growth unabated

The rapid growth in smart beta is illustrated by the high number of listed products. One in four exchange traded products (ETPs) listed on ASX are smart beta strategies. At the end of June 2019, 15 per cent of assets managed by the ETP industry were in smart beta products, up from 9.5 per cent in 2015. This represents 19.5 per cent of cumulative flows into ETPs since January 2015.